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Despite the challenges and the obvious risk of failure, Americans are starting small businesses in record numbers. The entrepreneurial spirit is alive and well but the difference today is that the tools have become so much better. And they are going to continue to improve, particularly as small business owners start taking advantage of the latest AI tools.
My guest today on the Fintech One-on-One podcast is Karen G. Mills. She is a senior fellow at the Harvard Business School, and she was the head of the Small Business Administration under President Obama from 2009 until 2013. She was first on the show back in 2015 and again when she wrote the first edition of her book, Fintech Small Business and the American Dream, back in 2019. She has now published a second edition that includes a deep analysis of the changes that the pandemic and the PPP had on the American small business landscape. She is very optimistic on American small business and thinks we are on the cusp of reaching small business utopia.
In this podcast you will learn:
- What has changed since Karen wrote the first edition of her book in 2019.
- The three layers of complexity that prevented the predicted changes from happening as fast as expected.
- Why she decided to write a second edition.
- Why the narrative about PPP fraud was not accurate.
- What fintech lenders did that traditional banks would not do during that time.
- The analysis they did to demonstrate the success of PPP.
- How the SBA performed in administering the PPP.
- Karen’s take on the state of community banks and small business lending.
- Why she thinks big tech is not going to dominate small business lending.
- Who the winners are going to be.
- Why small business lending is one of the biggest opportunities out there.
- Her vision for smart regulation of small business lending.
- What it will take to get to small business utopia.
- Why she is optimistic about the future of U.S. small business.
Read a transcription of our conversation below.
FINTECH ONE-ON-ONE PODCAST NO. 520 – KAREN G. MILLS
Karen Mills: Nobody had told the whole story analytically of the PPP and all the pandemic relief. So we got right down into the detail. We read every paper every economist had written, looked at all the data. And what we find is interesting. First of all, the narrative about fraud turns out to be not accurate. The SBA released their latest estimates and they say $36 billion fraud, which is 3 percent. And $30 of those $36 billion were recovered through subsequent efforts.
Peter Renton: This is the Fintech One-on-One Podcast, the show for fintech enthusiasts looking to better understand the leaders shaping fintech and banking today. My name is Peter Renton and since 2013, I’ve been conducting in-depth interviews with fintech founders and banking executives. On the show today, I am delighted to welcome back Karen Mills. She is currently a senior fellow at the Harvard Business School, and she was the head of the Small Business Administration under President Obama from 2009 until 2013. She has thought more about how to help American small businesses more than probably anyone else alive. Last year, she published the second edition of her book, Fintech Small Business and the American Dream. And today, we spend a lot of time discussing the findings of this book. We cover the PPP program, community banks, embedded lending, big tech, regulation, the future of small business and much more. Now let’s get on with the show.
Welcome back to the podcast, Karen.
KM: Well, I’m delighted to be back talking with you.
PR: Yeah, it’s great to see you again. So let’s kick it off. You wrote your first book, I think it was published in 2019, and I had you on the show for it then. I’ll link to the show in the show notes, but I’d like to get your perspective, because a lot has happened in the last five, six years. When you look at the small business lending landscape today, what do you see as the progress we’ve made since 2019?
KM: In fact, the book came out in April, 2019 and Peter, the launch day, I flew to San Francisco and did the launch at LendIt Fireside Chat with you.
PR: I remember it well.
KM: Back again together, talking about what’s different over these five years. And the answer is a tremendous amount. When I wrote the book, I described small business utopia and my thought at the time, and we talked about it, was that in five years, we would have this transformation of small business lending, that we would be able to have a much more seamless process, that it would be ubiquitous. And, of course, things proved to be a little bit more complicated and moved much more slowly. And I sat back, in thinking about this second edition, to say, why did it not happen as fast as we thought? And the answer is that there are three layers of complexity in the market that I think we didn’t fully appreciate at the time. The first layer is that the underlying data that informs some of the fintech insights and models just proved to be more difficult to standardize. So you had companies like Plaid and Codat that spent six or seven years really cleaning the data. Now, we do have the data available today, but it just took longer. The second layer of complexity is really much harder. It is that there are so many use cases for small business lending. From the small business point of view, one day, you’re lending to a dry cleaner, and the next day, you’re lending to a parts supplier. There are so many different kinds of small businesses, and they need different kinds of loans. So, one time, they need a term loan to buy a piece of equipment. Another time, they need a line of credit just for cash flow management. So there are all these different loan products, and each bank or lender has a different kind of loan product that they like to put out in the marketplace, Merchant Cash Advance. So that finding product market fit, finding the loan that is right for the business, turns out to be quite complicated. And then the top layer of complexity that maybe we’ll come back to later in the talk is about the user interface. It needs to be a seamless connection to a small business owner and a small business owner is busy, and it’s hard to have a user interface that really is appealing to that small business owner. So, all of these are areas where there’s been complexity, but there’s also been progress.
PR: Interesting. Well, we’re going to dive into some of those things later. But before we do, I want to first ask why you decided to write a second edition. Because you know, it’s a lot of work to write a book as you know well. Why’d you decide to jump in and do a second edition?
KM: Well, my publisher actually called me and said, “Why don’t you do a second edition?” I said, “Absolutely not.” It is way too much work. I’ve already written my book. And I went home that weekend, and I read through the first edition, and I thought, hmm, this is not current. The market has moved in a different set of ways. There are a whole number of things that need to get covered. For instance, 2019 was pre-pandemic. We had the biggest crisis in small business and a trillion two in pandemic aid. That whole tale needed to be told. And then there’s a whole set of chapters on the winners and the losers because the landscape had changed. So this second edition, there is software now that tells you how much is new, and it’s over two-thirds new.
KM: Right. So one of the things that’s new is you dive deeply into the Paycheck Protection Program, the PPP, and a lot of people have written about it, but I haven’t seen quite the analysis that you did. And I really appreciate it. I think you’ve done a great service for the industry because a lot of people say PPP was just so much fraud, it was just such a waste for the government to do this. But you actually dive into the numbers and you get the objective data. So maybe we let’s just start with fraud. What actually took place during the PPP? How much fraud was there?
KM: I’m glad you wanted to start with this because this was actually one of the hardest parts of the second edition to write because nobody had told the whole story analytically of the PPP and all the pandemic relief. So, we got right down into the detail. We read every paper every economist had written and looked at all the data. And what we find is interesting. First of all, the narrative about fraud turns out to be not accurate. The SBA released their latest estimates, and they say $36 billion in fraud, which is 3% of the 1.2 trillion. And $30 of those $36 billion were recovered through subsequent efforts. So the numbers are still big, you know, six billion of lost money is a lot of money, but as a percentage of the activity that went out. So why is this narrative out there? Early estimates were very, very high. The inspector general flagged about 17 % of the PPP as being fraudulent. And that’s $200 billion. So that number wakes you up. But it turns out that a lot of the flags that they use to worry about fraud turned out not to be fraud. For instance, duplicate applications. Well, many people applied two or three times to PPP because they were afraid that their bank wouldn’t get it. So they applied through a fintech, and all of those were early red flags. But they turned out not to actually be people accepting it fraudulently. The SBA got smart as progress happened, and all of the fraud happened in the very early time. The last two programs, the shuttered venue and the restaurant relief had under 1% fraud. So, they learned how to put more checks in the application. But in the beginning, Mnuchin said, we’re not going to go check this list against any other list, do not pay, because he was afraid, and I think correctly so, that he wouldn’t get the pickup and the participation if he made the application too complicated. And I give him credit because one of the great things about these programs is they had widespread acceptance eventually and saved lots of businesses.
PR: Yeah, they did, including ours. It’s interesting because that narrative of rampant fraud, if you just ask people who casually follow fintech, particularly in the small business space, a lot of people say, ”Oh, yeah, there was tons of fraud, but that’s okay, we got the money out.” But what you’re saying, and the evidence shows, is that while fraud is always an issue, it wasn’t nearly as big as what they expected, what was reported in the press at the time. And you remember those early days, I remember them, like the memory of that early April when the PPP came out. That’s seared into my brain because we just wanted to get that money because, you know, the focus was on speed, and there was frustration because banks, big banks, especially, were not moving fast enough. I do acknowledge the fact that, you know, I appreciate what Steven Mnuchin did in saying speed is the most important thing. And to me, it’s quite surprising, given the focus on speed, that there wasn’t more fraud.
KM: Yes, I think that’s right. You know, there were a lot of headline names, you know, Shake Shack taking money that they shouldn’t that they subsequently gave back. And we cover that. But at that moment, and I think we’ve forgotten how difficult it was, we were looking at the potential for a third of America’s small businesses to fail and to have shuttered storefronts on Main Street for literally years to come because it’s very, very hard to recover from something like that. So these efforts were really vital in making this V-shaped recovery that we eventually got.
PR: Right. So then let’s talk about the fintech lenders because that was really a time for the fintech lenders to step up, and many of them stepped up in a big way. So what did the fintech lenders do that traditional banks could not or would not do during that time?
KM: Well, as you said, the traditional banks were doing a couple of things. They were manually processing everything, and they were favoring their existing customers because they were their customers and also because that was a way to avoid fraud, and they were not willing to take any risk. So fintech brought speed. They were able to create automated processing, and they were able to pre-populate forms for people, which was like magic at the time. And then they did something else: they increased the program’s reach to sole proprietors and particularly minority-owned businesses, especially black-owned businesses. And there’s an economist, a very good economist named Sabrina Howell, who did some work that actually quantified what happened in that. The numbers are remarkable. And we put the graphs in the book. Fintech lenders accounted for 54% of all the PPP loans to black-owned businesses. So, 54 % of them came through fintechs. And of the loans that the fintechs made, 27 % of their loans went to black-owned businesses. So they were really important in creating access and opportunity because many of these businesses did not have a bank that was ready and willing to service them with a PPP loan. So it was game-changing.
PR: Right, right. So then looking back now, it was a costly program, as you said, the most costly program in US history when it comes to support for small business.
KM: $1.2 trillion. That’s a big number.
PR: Now, several years removed from it, do you consider the PPP to have been a success? Was it worth it?
KM: Absolutely, yes. And I say that not because of wishful thinking but because we did the analysis. We went back and used four criteria to measure whether PPP was a success. The first criterion is small business employment. Second was the survival of small businesses. Third was equity, getting the PPP to all kinds of businesses. And the fourth is the speed of deployment and the uptake by the small business owner. And we went through each of the economists. There were some early economists who wrote, “Oh, this is not getting to the right businesses. It’s way too costly.” And later analysis debunked that. It turned out that, especially in the smallest businesses, the ones with under 10 employees, they received 90% of the loans. It was incredibly effective in these analyses, particularly at increasing survival and its reach. Thirteen million small businesses got the loans. So, that is at least a third of small businesses in the US. And we can really look at the great recession and the U-shaped recovery where we didn’t have enough money deployed into the world of small business. And one of the big differences you can see in the employment numbers in that V-shaped recovery is because of the big emphasis in the government aid programs. It was the number one thing. It was the first thing in the CARES Act and it deployed at that time, $360 million [she meant billion]. Well, of course, that was gone in two weeks, and they had to go to this next piece. So I think it was absolutely vital in making us be able to come out of this relatively unscathed.
PR: Right. Well, before we move on, I think you’ve got a unique perspective here because you were the head of the SBA under President Obama. And so the SBA was front and center here, and knowing what you know, how the inner workings of the SBA operate, how do you think the SBA handled this whole situation? Very difficult, very challenging, obviously, for not a large agency, really.
KM: Not a large agency and an agency that, you know, had been under-invested in by the government budget and in technology. And I give particularly Isabel Guzman, the head under Obama, a lot of credit because she went through and created the systems that allowed quickly the seamless deployment of PPP in its second loans and the other programs and the idle loans and followed through on all the fraud pieces. The SBA is really humming, and it is largely due to real attention to execution and detail during that period
PR: Okay, so I want to switch gears a little bit. I want to talk about community banks. You cover them in the book as well. Community banks have been one of the real driving forces for small business lending for decades. But now they’re being challenged, and some people talk about vertical SaaS companies as the new community banks because they have such intimate knowledge of their clients, like community banks used to have and still do to some extent. What’s your take on the state of community banks and small business lending?
KM: Well, I have a great love for community banks. They were our partners at SBA, but I think they play a vital role and a unique role. There are other countries who wish they had the system we have of community banks. So they’re a unique asset. Here’s how I see the vertical SaaS companies. I think they also are going to be great assets and winners in this transformation. But vertical SaaS companies, like Toast, for instance, Toast serves restaurants and it knows it’s already in the daily routine of a small business owner. So it has an absolutely perfect way to have a small business owner come in and say, well, I’d like a loan. This is embedded lending. And, of course, we’ll get to embedded lending, but it is one of the critical new aspects of fintech. You should get your loan embedded in your workflow. What we know now about embedded lending is that the Vertical SaaS company really doesn’t want to be a bank, it doesn’t want to be the lender. It wants to have the interface; it wants to provide the service to the small business, but underneath, there’s another layer, which this middle layer, for instance, might be done by Stripe or now Intuit. And it creates the pipes, and maybe even the algorithm, where the loan is assessed and evaluated, and the information is flowing. At the bottom layer, there’s a bank, or there’s a provider of capital, but usually, it’s a bank because banks are the people who provide the money, and if you have this bank at the bottom, they can now have a whole new line of business which is Banking as a Service, and Banking as a Service is an enormous opportunity for community banks and for large banks. So, I see embedded lending as a massive trend for the future, but a trend that includes banks. I also see community banks winning in their own right, because as the core software providers, Jack Henry and others, are working to make the core systems more flexible, they will be able to have their own technology that does the underwriting in a more seamless way. And then they, the lending officer, instead of filling out an Excel spreadsheet, can go back to being a relationship manager and provide the advice and counsel that has been their critical role in the past. So I see a bright future, actually a brighter future than ever for community banks. I think they’re a huge asset and they’re going to win.
PR: Interesting. Interesting. So then, what about the big tech companies? Because Amazon has been in the small business lending space for some time. Square has been doing it also for a long time. PayPal, again, these are tech behemoths and, you know, hard to compete against for anybody. Do you think they’re going to dominate small business lending over the next decade?
KM: I have a whole chapter on winners and losers. And it’s very interesting that you ask about big tech because when I go out and talk about the book, I always have the audience vote between four categories. I say, “Who’s going to win? Is it going to be big banks, traditional lenders, or credit card companies? Or is it going to be big tech? Is it going to be the challenger banks, or is it going to be the infrastructure players?” And lots and lots of people choose big tech, every audience, for all the reasons that you just mentioned. You know, they have the technology, they’ve got the reach, and they’ve got brand and trust, which some of the challenger banks don’t. But, the problem is, they have too many other opportunities that they want to pursue. And in the US, they have shown absolutely no interest in going into fintech in a big way. Apple, a little bit, Amazon only to finance their vendors. So, if they have another reason in their ecosystem that they want to provide a lending product, they may do it. But we have seen no indication because they just don’t want to be regulated, and they have too many other opportunities. So far, not like Alipay, so far they are not taking that role.
PR: Right, right. So then, who is going to be the winners, do you think, when it comes to small business lending in the future?
KM: Well, as I said, I think that embedded platforms are going to be a huge part. I think challenger banks have a harder time reaching small businesses, and they have a very hard time with the cost of capital. So this idea of the embedded structure, I think, is going to be the biggest player. And there are many, many ways that can come about. You know, given all the vertical SaaS platforms, it could come about on Amazon, it can come about with lots of different folks in the front end. The middle layer is going to be very important and Intuit, I believe, is going to be an interesting player besides Stripe and others in that middle layer. And then, banks are going to choose if they want to start to participate. And I have been waiting for the big ones, the JP Morgan’s, to realize that this is a big opportunity. So far, they haven’t, but I think maybe the regional banks may. And then, as I mentioned before, I have this dream that the community banks are also going to win because of their unique position in the relationship as the technology infrastructure products just get more plug and play.
PR: Right, right. Because it’s interesting, there really isn’t a brand name bank or fintech that has taken a massive market share in the small business lending space. It’s funny because it’s like we had the first wave of fintech with, you know, the OnDecks and Kabbages and Funding Circles of the world really, I think, did a great job in kind of bringing that first innovation to small business lending. All three of those companies I just mentioned have been acquired, but there’s no brand that really has sort of bubbled up to the top to be the company that’s going to dominate small business lending. I mean, it’s not a winner-take-all field for sure, but it feels like it’s still pretty wide open. Wouldn’t you say?
KM: I think it is the biggest, most interesting tech opportunity out there, one of the biggest, because there is nobody, as you mentioned, occupying the space. It’s quite a large space. I think the reason we haven’t seen it yet, besides some other complexities, is the use case issue. There is room for a lot of winners as they craft different use cases. Square, for instance, really captured this sort of very small loan merchant cash advance kind of platform for a certain kind of user. But there’s plenty of room for American Express, which has got their blueprint out there, to begin to capture a sort of more traditional term loan revolver market and for regional banks to step in with products or Stripe to really qualify their own lending. So all of them are sort of circling around it, but they can’t quite figure out this product market fit use case issue. Should they go in through a vertical? Should they go in, you know, through a product type? And that’s why I think it’s been slow to materialize.
PR: Okay, so I want to talk about regulation for a bit because I know towards the end of your book, you devote a couple of chapters to this, and you critique the current system, which is fair because it’s not a great system. But what I appreciate is that you laid out your vision for really how regulation could work. So maybe you could take us through that.
KM: There’s a lot of talk now about more regulation or less regulation. We’re going to take away regulation. This more versus less, I think, is exactly the wrong dichotomy. It is a nonproductive discussion. What you want is smart regulation. The focus really has to be on how do you create an environment that is going to protect lenders and borrowers and small business owners, but also foster innovation. And this is what the UK was able to do right after the financial crisis with the FCA and the whole regulatory structure. And that’s why fintech blossomed there. The US is way behind. And I was laughing about Congress was all worried about the SBA licensing two or three fintechs. And they completely missed the boat that all the other fintechs are operating in an unregulated environment. This doesn’t protect the data, this doesn’t protect the small business owner, and it doesn’t protect the U.S. financial system. So we’ve begun to see some progress on that with 1033 and some other regulation around open banking. But we need to get much more serious, and the banks have to realize that fintech is not something the bank lobby just wants to, you know, block any fintech from becoming a bank or becoming regulated. What they need to realize is these are going to be their partners and they need to be safe and secure holders of data and operators. Otherwise, we’ll have another crisis like Synapse and we’ll have potentially enough of these crises that we can create destabilizing events in the economy. Regulation, smart regulation, not more or less, is absolutely the key to the financial services, fintech, and small business banking success.
PR: Right. I want to go back and revisit Small Business Utopia because it’s a beautiful sounding term, and you’ve painted a pretty vivid picture, and you give a great example in the book about what it can look like. And we have the pieces in place now. It feels like the technology has been developed. What do you think it’s going to take to get to small business utopia from here?
KM: Well, there is still a missing piece that is emerging, which is this top layer of the user interface. And the catalyst, of course, is AI. And it is really the generative AI, because we’ve had AI and fintech for a long period of time with machine learning. But this generative AI, this bot who is going to be your sidekick, your buddy, is the missing piece for small business utopia. Because today, if you’re a small business owner and you get a tool to look at your cash flow or you get a piece of software, you have to buy the software, download the software, learn how to use it, go in, get some insights and then do all the work yourself. What if you had a buddy who was an artificial intelligence bot, and that sidekick would do the work for you? You could say, “Go look and find out when I’m going to need cash. Figure out what the best loan product is for me, and give me five or six options of products that I might consider, and tell me their pluses and minuses.” You can tell them, “Figure out when you should put down coupons. What’s my competitor doing?” And they can start doing some of the work for you, particularly on the sales and marketing side, but also on the cashflow analytics side. This kind of intelligence does exist today and slowly, I think financial services companies are figuring out how to train them and to create this intelligence. And when you have a trusted helper, who knows everything about your business and can work with you and do some of the work for you, then you’ve got Small Business Utopia.
PR: Right, right. And this year, I’ve been reading a lot in the fintech press about AI agents and what role they’re going to play. And that’s kind of what you’re talking about here. I don’t think we’re far away. I mean, it’s not this year that it’s going to become ubiquitous, but you know, two to three years, I can’t wait for that. I want that product.
KM: Everyone wants that product.
PRL I think it’s going to be great. Okay. So then let’s close with, as you consider that, it sounds like you are optimistic about the future of small business in this country. Maybe you could tease out why you’re optimistic and why you think the next decade is going to be different from the last decade.
KM: Well, I am optimistic about the future for small business, and particularly this sort of technology-enabled part of that. You know, back in June of 2020, something really unbelievable happened, and economists still don’t know why. And that was that the number of monthly applications to start a new business went up by 50%. So now we’re in the middle of the pandemic. Everybody thinks, you know, we’re all going to die or at least worry about that. And here you have more and more people starting a business. This American spirit of entrepreneurship cannot be contained. And in fact, in the most dire times when you give it a little money because people had a little cash, they had a little time, they just started all these businesses. And then the trend never went back. If you look at the graph, it went up 50 %, and then it continued at this new rate of entrepreneurship. So, there is still life in America’s entrepreneurial spirit. What will happen with technology is that we will take away some of these frictions and barriers. It is hard to start a business. It is particularly hard to get the money. What if all this works and we get small business utopia, which, you know, all the technology really exists. There are no dramatic breakthroughs that have to happen. It’s just assimilating it into the lives of small business owners and making it work for them. I believe that will happen. And if that happens, we will be able to transform small business ownership in a way that is so dynamic that it will create new energy and really new opportunities for the American economy.
PR: Right. And I couldn’t agree more. The thing as an outsider, someone who came to this country to start a small business, what people don’t fully appreciate inside America sometimes is that everyone who is an English speaker, or even if you’re not an English speaker, if they’re an entrepreneur, they want to come to America because this is the land of opportunity. It still is. You’ve just painted the picture that it’s going to remain that way for some time. And the American spirit, the entrepreneurial spirit, is alive and well and with the tools that we’ve got. It could be a very exciting next decade.
KM: Well, this is why I call the book The American Dream, you know, it takes small business in the American dream because small business gives access and opportunity. It is a way that people have come to this country or been here and been able to create opportunity and the way to move forward. So if we have this more, we will really be able to energize and create more of the American dream.
PR: Okay, Karen, we’ll have to leave it there. So great to chat with you as always. Thanks again for coming on the show, and maybe I’ll get you back on when we’ve reached Small Business Utopia.
KM: Thank you.
I am also very optimistic on the future of American small business. Starting a business is already cheaper and easier than it was a decade ago. Running a business is also easier, with so many great online tools available to help the entrepreneur succeed. But these tools are only going to get better, much better. As Karen says, once we have developed specialist AI agents for small businesses and we improve the user interface, I see us getting very close to the Small Business Utopia that she describes in her book. We could very well be on the cusp of a new golden age for American small business.
Anyway, that’s it for today’s show. If you enjoy these episodes, please go ahead and subscribe, tell a friend, or leave a review. And thank you so much for listening.